Rebalancing 101: How to keep your portfolio healthy

Occasional tweaks of your investment mix can help you protect your nest egg

Modern life is all about striving for balance. We’ve got our work-life balance, our balanced diets, and yes, our balanced portfolios.

Picture your portfolio as a pizza pie with toppings that vary by slice. You’ve got slices of stocks, bonds, maybe some alternative investments such as real estate or commodities and cash. In a healthy portfolio, each of these slices will stay close to its original size so that no particular toppings—or assets—dominate the pie.

This is a particularly good time to think about rebalancing, because U.S. stocks have had quite a run this year, up nearly 30%. Bonds have lagged behind by comparison. Even if you bought no stocks at all this year, by virtue of their dollar appreciation equities are very likely to represent a bigger portion of your pie than they did at the start of the year. They might be 66%, say, when they started out as 60%. Periodic rebalancing will bring them back to your original target.

Why is this important? For starters, the greater your stock allocation, the more volatile your portfolio, so 66% might represent more risk than you’re comfortable with, especially if you’re nearing retirement. An outsize allocation to any one asset can leave you more vulnerable if that asset crashes—think tech stocks in 2000.

Shutterstock.com

If you tip the scales too far toward any one asset, your portfolio will become more vulnerable to rocky financial markets.

What’s more, rebalancing forces you to sell off some of the highfliers in your portfolio and buy the laggards. “It’s a self-imposed discipline of buying low and selling high,” said Jerry Miccolis, chief investment officer for Brinton Eaton Wealth Management in Madison, N.J. and co-author of “Asset Allocation for Dummies.”

A disciplined rebalancer would probably have sold stocks in late 1999 or early 2000 when shares of companies like Cisco Systems
CSCO, -0.17%
were near their peaks. That stock’s price hovered near $80 at the height of the tech boom; it trades for much less today.

Finding the right asset mix

Rebalancing begins with determining the appropriate asset allocation for you. While the right division of stocks, bonds and other assets will depend on your individual goals and risk tolerance, planners advise against becoming overly conservative as you approach and then enter retirement. All but the very rich will need a healthy stock allocation—think at least 40%, for a rough ballpark estimate—to help grow a portfolio over a retirement that could span decades.

Once you’ve got your allocation set, revisit it periodically to make sure the assets haven’t strayed too far from their targets. Some experts advocate a 20% change as a good threshold for action. Let’s say you allocated 10% of your portfolio to real estate stocks—20% of that would be two percentage points either way, so you’d rebalance if your real estate slice shrank to 8% or less or expanded to 12% or more.

If a given slice has shrunk by your trigger amount or more, buy whatever amount will bump you back to your target allocation. While you’re at it, sell a portion of whatever asset has appreciated the most in your portfolio, to return it to its target allocation. Reverse this process if the slice has grown: sell some of it and buy more of a slice that has shrunk.

To figure out the correct new amount for each asset, take the total current dollar value of your portfolio and multiply it by the percentage weighting originally assigned to each asset.

It’s best to rebalance across your entire portfolio—that is, all the investments you own in all your different accounts. Different slices of the pie may be held at different brokerage firms, and it’s important to consider the pieces together. Selling winners can generate capital gains, so ideally you’d sell off appreciated assets in your tax-advantaged accounts like 401(k)s and IRAs to avoid incurring capital gains taxes.

Don’t change too often

How often should you rebalance? Ideally, investors would rebalance when their portfolio strays from its allocation, instead of on a fixed calendar schedule such as semiannually or annually, Miccolis said. Whatever method you choose, experts advise that it’s best not to rebalance more frequently than quarterly, to avoid incurring excessive transaction fees.

In reality, few regular investors are engaged enough to proactively rebalance as needed, said Fran Kinniry, principal in Vanguard Investment Strategy Group. For one, folks are busy, and rebalancing might fall somewhere on the to-do list between cleaning out the garage and shredding old documents.

What’s more, rebalancing requires the difficult psychological move of selling some of your winners and buying some losers. (Note: A portfolio’s losers don’t actually have to be losing money; they could just be appreciating at a slower rate than everything else.)

It felt pretty good in 1999 to be sitting on a portfolio of soaring tech stocks—who would’ve wanted to sell some and buy a boring asset instead? Professionals called value investors specialize in buying the underdogs of the market, but it’s a tall order to expect regular investors to follow suit, experts say.

Options for the reluctant

Luckily, the reluctant rebalancer has a few options. One is to invest in a target-date fund, a mutual fund that automatically resets its asset mix according to a future goal. A 2040 retirement target-date fund, for example, would shift assets to become increasingly conservative as it approaches that date.

Another option is to set your portfolio to rebalance automatically. Many brokerage firms allow you to set your parameters and rebalance automatically according to them. ADP Retirement Services administers some 41,000 company retirement plans that cover almost 1.5 million employees; about 40% of the plans have participants who take advantage of auto-rebalancing. The most common frequency is annually, said Chris Augelli, vice president of product marketing and business development. The downside of this set-it-and-forget-it approach is that it’s hard to sync accounts held across multiple brokerages.

As important as rebalancing is, it’s equally important not to stress over every blip in the market, advisers say. Today’s technology means market quotes are rarely more than a finger tap away, which can be dangerous for those who are prone to react. Said Kinniry, “You don’t have to micromanage this.”

Mortgage Rates

Powered by

This advertisement is provided by Bankrate, which compiles rate data from more than 4,800 financial institutions. Bankrate is paid by financial institutions whenever users click on display advertisements or on rate table listings enhanced with features like logos, navigation links, and toll free numbers. Dow Jones receives a share of these revenues when users click on a paid placement.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.